Thursday, October 18, 2012

As
consumers, particularly Canadian consumers, we are constantly being warned
(usually by Mark Carney) that the current level of consumer debt accumulation is well
into the danger zone. Other than occasional musings about Ontario's debt
level, we rarely hear anything about the dangers and sustainability of
provincial debt accumulation. In a recently released Fiscal Sustainability Report by the
Parliamentary Budget Officer, Randall Bartlett, Scott Cameron, Helen Lao and
Christ Matier examine the levels of provincial-territorial-local government
debt and look at whether or not these levels are sustainable.

Let's open
by looking at a graph that shows the past and projected levels of government
sector net debt-to-GDP from 1991 to 2086:

The blue
line shows the rapidly growing level of provincial-territorial-local (PTL) debt
after 2032 with growth in debt far outstripping economic growth over the
long-term. By 2086, PTL debt will reach 350 percent of GDP. To put
this number into context, Japan, the world's most indebted nation when measured
against GDP has a debt-to-GDP level somewhere around 200 percent. As
shown on the following graph, part of the problem with PTL debt can be laid at
the feet of the federal government; beyond 2016 - 2017 as its most recent
budget incarnation reduced growth levels in the Canada Health Transfer, Canada
Social Transfer and other federal transfers:

This will
put the onus on the provincial and territorial governments to cover the
shortfalls (aka fiscal gap) which will increase as Canada's population ages.

Here is a
graph showing the dropping federal Canada Health Transfer relative to PTL
health spending as a percentage of GDP:

Here is a
similar graph showing the dropping federal Canada Social Transfer relative to
PTL health spending as a percentage of GDP:

You can
quite quickly see why the provinces and territories will end up with
ever-rising debt-to-GDP levels. On the upside, these cuts will help
balance the books of the federal government which will end up with a fiscal gap (surplus) of -1.4 percent of GDP compared to the PTL gap of +2.0 percent as shown here:

As a result, provincial governments will be forced to take the following actions:

1.) Raise
taxes.

2.) Reduce
program spending.

3.) A
combination of the two.

Starting in
2012, to cover the looming fiscal gap, provinces as a whole will have to
implement $36 billion in tax increases or program spending cuts. This
amount will increase over time following growth in GDP. Delaying these
actions by a mere five years means that the fiscal gap grows from 2.0 percent
to 2.3 percent, delaying by ten years to 2.6 percent, by twenty years to 3.4
percent and by thirty years to 4.7 percent of GDP.

Here is a
bar graph showing PTL internally sourced revenue as a percentage of GDP from
1961 to 2086 assuming that the tax burden remains constant:

Here is a
bar graph showing total PTL program spending as a percentage of GDP from 1961 to
2086:

Most
critically, here is a bar graph showing PTL health spending as a percentage of
GDP from 1975 to 2086:

As Canadians
age, the PTL spending on health care is expected to rise from 7.6 percent in
2011 to 12.1 percent of GDP in 2050 and 14. 6 percent in 2086. Over the
period between 2011 and 2032, the authors project that PTL spending on health
care will grow at an average annual rate of 5.1 percent.

I think that you can see where this is heading. Keeping all
of this data in mind, here is a graph showing what will happen to the
provincial debt picture as the decades pass:

As the years
pass, more and more of PTL revenue will be required to repay mounting levels of
interest owing on the ever-increasing debt. In all likelihood, the
interest rate spread between federal government and provincial government will
also rise as bond raters look less favourably on the ability of provinces to
service their debts; this will be particularly apparent in provinces with low
levels of economic growth (most of Atlantic Canada) and those with high debt
levels (Ontario and Quebec).

It is quite obvious that the current scenario is unsustainable over the long-term. Unfortunately, one way or
another, Canadian taxpayers will feel the pain. Even though the federal
government may (and that's a big "may") achieve some sort of
semblance of fiscal balance, it will likely be done by downshifting the deficit
load to the provinces and, since all Canadians pay provincial income taxes,
that means that we are the ones that will ultimately pay.

2 comments:

I am wondering how it's possible to make such a forecast? All observations point out that even in one-two year term everything could go wrong and 70-year long forecast can be considered just for entertainment purposes.

Nice graphical misrepresentation, starting the Y-axis at positive values when a 0 value is called for. Health spending appears to multiply by a factor 5 until you realize that the graph doesn't go lower than 4%.

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.